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July 14, 2014

Germany Still Industry Leader Despite Industrial Output Drop

A 1.8% decline in German industrial output—the sharpest plunge in more than two years—caused concern recently, leading some economists to even lower their forecasts for German economic growth.

Others are wondering whether the drop heralds larger and more lasting problems for the industrial sector, which led the German economy through Europe’s sovereign crisis, but for Stefan Schneider, Chief International Economist and Head of Macroeconomics Research at Deutsche Bank in Franfkfurt, it’s too early to jump to any conclusions.

Reindustrialization and overall industrial competitiveness, as well as their importance to Eurozone growth, are important topics today as Europe’s battered economies regain their strength. Countries like Spain and Italy are struggling to reinvent and reinvigorate industry, as it were, and for others like Greece, France and even the U.K., industry accounts for a mere 10% of economic output, according to recent Deutsche Bank research.

Yet Germany still maintains a significant edge over other countries, Schneider said, and the attributes that allowed German industry to flourish during the worst of the crisis years are still present today.

“When it comes to Germany, people always look at the car industry and industries like mechanical engineering, which are sort of the beacons of the sector, but if you go to backwoods of Germany, you will find other companies and many small- and medium-sized enterprises that are into smaller, micro-industry type production,” Schneider said. “There are lots of companies that produce very specific and sophisticated things that to a certain extent piggy back on the larger mechanical engineering or automotive sectors.”

What’s important in Germany is that there’s a “re-fertilization” both ways, Schneider said. Germany’s industrial strength is based on a “feed in-feed out” dynamic, he said, and niche expertise in selected areas means that production has not only stayed within the country, but also enabled Germany to maintain greater competitiveness than other European country.

“Take Italy, for instance. It used to have quite a successful industrial sector, but now Italy faces head-on competition with China, which produces the same goods as they do,” Schneider said. “To be successful in industry, you have to be inventive, you have to be in the lead on technological advancement and Germany has been good at that.”

Like other German economists, Schneider believes that the 1.8% downturn in industrial output is largely the result of seasonal factors. There were many public holidays during the time period the figure reflects, he said, and an unseasonably warm winter resulted in a strong first half of the year, so it’s expected that output in the second half of the year would be slightly weaker.

And of course, global conditions haven’t been too favorable for German exports, in particular the geopolitical tensions created by the Ukraine crisis, compounded now by the crisis in Iraq and the Middle East, Schneider said.

“We need a strong global economy and in addition to anecdotal evidence that suggests that exports to Russia have been a tough sell, China and the U.S. have both disappointed, and overall, German export numbers are not good,” he said. All of the above notwithstanding, though, if Germany is to maintain its edge in industry, then it faces the same challenges other European countries face in continuing to ensure that its companies can compete against global forces, in particular non-European rivals. Like any other country, Germany must continue to invest in education, research and infrastructure – which a number of studies have singled out as becoming significantly weaker in Germany – and also continue to foster an investment friendly climate, Schneider said.

Germany also faces a number of more macro challenges, including relatively high energy prices and an aging population, both of which do place constraints on industrial development and production, Schneider said. The aging population is particularly important, he said, “because that is going to determine the labor force and where companies should and shouldn’t place their factories.”

Earlier this year, Germany also introduced a minimum wage. The country was one of the few in Europe not to have a minimum wage requirement and though the measure did go through, it nevertheless met with considerable opposition and many are still not happy with it, believing that rather than support employment, it might actually prove detrimental.

The introduction of the minimum wage could indeed lead German companies to outsource jobs elsewhere, Schneider said, although he believes that dynamic is losing steam, because wages in places like China have also increased and there’s less incentive for European companies to outsource labor there.